Advanced Taxation

Hong Kong
(ATX HKG)
Dec 2022
Examiner’s report
The examining team share their observations from the
marking process to highlight strengths and
weaknesses in candidates’ performance, and to offer
constructive advice for those sitting the exam in the
future.

Contents
General Comments ............................................................. 2
Format of exam ................................................................ 2
Approach and guidance ................................................... 2
Comment on individual questions ....................................... 3
Question 1 (Precise Laboratory Services Ltd) ................. 3
Question 2 (Francis and Joyce) ....................................... 6
Question 3 (Hong Kong Squash Club) ............................ 8
Question 4 (Inter (HK) Ltd and Loss (HK) Ltd) ................ 9
Conclusion ......................................................................... 11

Examiner’s report – ATX HKG Dec 2022 1

General Comments

Format of exam

The examination consisted of a three-hour and 15-minute exam containing two

sections with all four questions being compulsory. In Section A, Question 1 carried
35 marks and Question 2 was for 25 marks, while in Section B, Questions 3 and 4
were for 20 marks each. Four professional marks were awarded in Question 1 for
logical approach, appropriate presentation of the report and effective communication.
This report should be used in conjunction with the published exam which can be
accessed via the ACCA website.

Approach and guidance

The purpose of the advanced taxation examination is to test the candidates’ ability to
apply tax laws and principles, considering the different perspectives of employer and
employee, client and tax adviser, taxpayer and tax authorities, business acquirer and
acquiree, together with the taxpayer entity and its shareholder or associates, in the
context of the scenarios provided in each question.

Most candidates were able to demonstrate an average standard of typing skills and
there was no indication of any candidate suffering any difficulty in working between
different exhibits or having time pressure in completing the paper. In those cases
where questions were not well-performed or left unanswered, this appeared to be
due to a lack of knowledge in that topic area or simply inadequate preparation.
These areas include taxability of clubs in Question 3 and interest deductibility in
Question 4.

Better performance was found in Question 1 (35 marks) which was mainly
attributable to the good knowledge of general tax deductibility rules for employee-
related expenses.

As noted previously, there was observation that more candidates tried to copy-and-
paste the facts directly from the questions to their answers without elaborating or
addressing the tax issues as required. Some other candidates were found giving
irrelevant answers, such as incorrectly focusing on the assessability of remuneration
items to the employee instead of the deductibility of the same items to the employer
as required.

Well-performed questions included Q1(a) on the rights of the tax authority to raise
tax queries, Q1(b)(i) on the general tax deductibility of the expatriate employee’s
salary cost, Q1(c) on the taxability of a non-resident company, Q2(a) on the
assessability to salaries tax of employment income, and Q4(a) on the general
deductibility of interest expenses.

Worst-performed questions included Q1(b)(ii) on the tax deductibility of share option

costs, Q2(a) on relief from double taxation, Q2(b) on the tax position in respect of the
share of partnership profit/loss, Q3(a) and (b) on clubs, Q4(b) on the application of
the interest flow-back test under s.16(2B), and Q4(c) on the interest deductibility rule
for intra-group financing expenses. Despite that, some progress was noticed in the

Examiner’s report – ATX HKG Dec 2022 2

performance on the common topic of interest expense deductibility. However, the
examining team is still concerned that some candidates are not able to master some
concepts correctly and sufficiently well enough to achieve success in this exam.

Comment on individual questions

Question 1 (Precise Laboratory Services Ltd)

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This was a 35-mark question addressing the implications of tax queries raised by the
Hong Kong Inland Revenue Department (IRD) to a Hong Kong taxpayer company
(PLS), including the IRD’s rights of raising queries, the potential concerns on the tax
deductibility of certain remuneration items of an expatriate employee, and the Hong
Kong tax implications arising from the non-resident company making sales in Hong
Kong through PLS. Candidates were also required to present their answers in the
form of a report, for which most candidates were able to score good marks. This
question achieved a good performance which was mainly attributable to the general
tax administration knowledge and the common tax deductibility rules on the cost of
the employee.

For the average candidate with correct tax concepts, this question should not be a
challenge for them to score high marks. In cases where performance was not
satisfactory, candidates gave irrelevant answers by focusing on the salaries tax
assessability of the remuneration items to the employee, rather than the tax
deductibility of the same items to the employer.

Common errors were summarised as follows:

Part (a)
- Incorrectly stating seven years instead of six years for raising additional
assessments or raising queries

Part (b)(i)
- Incorrectly treating the remuneration cost which is not deductible because Mr
Miller’s employment is not Hong Kong employment
- Not understanding that the remuneration cost is deductible to the company but
only if the same is taxable by Mr Miller in Hong Kong

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- Incorrectly focusing on Hong Kong salaries tax assessability of Mr Miller in
respect of the remuneration, criteria and conditions for HK and offshore
employment, or Goepfert principles

Part (b)(ii)
- Not understanding that the share option cost is not deductible as Mr Miller is not
the employee of a HK company or the employment is not Hong Kong
employment, the option does not relate to a HK company and the equity-based
option is capital in nature
- Not knowing that the share option cost is deductible for the HK company but only
if the share option is taxable by Mr Miller for Hong Kong tax
- Incorrectly focusing on the HK salaries tax assessability of Mr Miller on the share
option, including the calculation of a taxable gain

Part (b)(iii)
- Incorrectly treating the non-home country tax which is not deductible as Mr Miller
is not the employee of the HK company or Mr Miller’s employment is non-Hong
Kong employment
- Incorrectly focusing on the Hong Kong salaries tax assessability (s.8 or s.9) of
the non-home country tax paid by employer

Part (c)
- Confusing service fee earned by the HK company with the sales revenue of US-
Holding
- Incorrectly applying HK tax rate on the 1%/0.5% of sales revenue

Examiner’s report – ATX HKG Dec 2022 5

Question 2 (Francis and Joyce)

This was a 25-mark question which tested candidates’ knowledge of related tax
issues associated with employment income including the source of employment,
exemptions and double tax relief, tax treatment of various income, partnership
allocation, property tax and stamp duty implications for the acquisition and leasing of
property, concessionary deductions and allowances.

Part (a) on assessability to salaries tax of employment income was the best
performed, probably because this is a commonly examined topic and candidates
were better prepared for it. Most candidates were able to explain the scope of
charge to salaries tax, the exemptions for all services rendered outside Hong Kong
and during visits not exceeding 60 days. However, quite a few of them did not
comment further on the application of the exemption, and did not explain whether
Francis’ income was exempt or not for 2020/21 and 2021/22.

Relief from double taxation was badly answered. While some candidates were
aware of the relevant exclusion of income under s.8(1A)(c), they were not aware of
the amendment made in 2018/19 that the exclusion will not apply if double taxation
arises in a Double Tax Agreement territory and that tax credit relief has to be
claimed.

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Part (b) was poorly answered. Many candidates were not able to explain the
allocation of profit/loss to partners, the treatment of loss under profits tax and
personal assessment (PA). Many candidates wrongly treated partners’ salaries as
deductible under profits tax and assessable under salaries tax.

Part (c) on property tax and stamp duty implications for the acquisition and leasing of
the property and part (d) on available concessionary deductions and allowances
were satisfactorily answered. However, performance for part (e) on the overall tax
position for the couple was not satisfactory.

Other common errors included:

Part (a)
- Applying time-apportionment to the HK employment
- Explaining that the 60-day exemption did not apply to the HK employment
- Stating that Hong Kong residents could not be making visits to HK
- Treating the foreign tax paid as an allowable deduction from assessable income
- Not being aware that the taxability of the share option benefit depended on
whether Francis was chargeable to salaries tax in the year the option was
granted, not in the year it was exercised

Part (b)
- Not explaining the allocation of profit/loss to partners or the treatment of loss
under profits tax and PA
- Not preparing the allocation of partnership’s profits

Part (c)
- Not commenting on the deductibility of interest and the splitting of net
assessable value and allowable interest between the couple under PA
- Not calculating the stamp duty payable

Part (d)
- Not explaining the treatment of approved charitable donations (ACD) under PA,
noting that the excess ACD can be transferred to the spouse
- Incorrectly allowing a child allowance for the son who was not a full-time student

Part (e)
- Wrongly advising the couple to elect joint assessment instead of personal
assessment
- Failing to provide any calculation of the net chargeable income, which was
specifically mentioned in the requirement

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Question 3 (Hong Kong Squash Club)

This was a 20-mark question, which examined the tax treatment for a club and the
stamp duty implications arising from the acquisition of a car park. It was not
particularly difficult or challenging, however, overall performance was very poor,
probably because the topic of special industries is not commonly examined. Many
candidates had left parts (a) and (b) unanswered, and a few candidates did not
attempt this question at all; probably because of lack of knowledge.

Part (a) on the current tax position of the club was poorly answered. Most
candidates were not aware of the special tax treatments for a club provided under
s.24(1). Instead, they explained the application of the 2-limb test under s.14 and the
badges of trade to decide if the club was carrying on a trade or business and
chargeable to profits tax; both of which were irrelevant.

Performance for part (b) was disappointing. Candidates were not able to explain the
tax implications of the proposals to the club if more than half of the gross receipts
were received from non-members. Many candidates failed to explain the property
tax and profits tax exposure of leasing out the car park, the exemption and relief for
double taxation under property and profits tax.

Performance for part (c) on stamp duty payable on the acquisition of a car park was
far from satisfactory. Although some candidates were able to identify the car park as
a non-residential property, they had wrongly applied the stamp duty rates which
applied to residential properties. Some candidates did not discuss whether special
stamp duty and buyer’s stamp duty were applicable.

Other common errors included:

Part (a)
- Incorrectly focusing on the source of profits

Part (b)
- Instead of explaining that the whole of profits were taxable if the club was
deemed to carry on a business under s.24, some candidates incorrectly focused

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 on how the club could avoid being chargeable to profits tax
- Incorrectly advising that the club, as a corporation, was eligible for the exemption
under s.5(2)(a)

Part (c)
- Applying the wrong stamp duty rate under Scale 2 or Scale 1 Part 1
- Incorrectly stating that lease agreements would be prepared for the car park and
explaining the stamp duty payable

Question 4 (Inter (HK) Ltd and Loss (HK) Ltd)

This was a 20-mark question which examined the popular topic area of interest
income assessability and interest expense deductibility. The scenario involved three
associated companies with inter-company loans. This topic is commonly examined
in ATX HKG. Well-prepared candidates were able to score good marks.

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Part (a) examined the tax deductibility of a loan interest payable by a Hong Kong
company to an overseas associate. Some candidates were able to gain very high
marks from this part but some other candidates demonstrated incorrect interpretation
of the tax principles and concepts.

Part (b) examined the tax deductibility of a loan interest payable by a Hong Kong
company to another Hong Kong associate. This was obviously a contradictory
scenario from part (a) and candidates were expected to highlight the difference and
give a different analysis leading to a different conclusion. Disappointingly,
performance in this part was not as satisfactory as would be expected. The major
problem was the misapplication of the ‘interest flow-back test’ under s.16(2B) in the
scenario.

Part (c) required candidates to assess the Hong Kong tax position of a Hong Kong
associate in respect of its interest income assessability as well as interest expense
deductibility in its capacity of an intra-group financing business. This part was also
not satisfactorily performed. Some candidates gave irrelevant answers by discussing
the criteria leading to a qualifying corporate treasury centre (QCTC) and the
preferential tax treatment for a QCTC.

Common errors included:

Part (a)
- Not differentiating between S.16(1) and s.16(1)(a) (Tutorial note: s.16(1) requires
‘the interest’ to be incurred in the production of assessable profits, while
s.16(1)(a) requires ‘the loan’ to be used for the production of assessable profits).
- Not noticing that when s.16(2A) or s.16(2B) applies, the interest is not deductible
at all (Tutorial note: the effect of s.16(2A)/(2B) is to ‘restrict’ the amount of
deduction, not to disallow the deduction at all. If a restriction applies, the
deductible amount is arrived at by deducting the non-taxable interest income
involved in the loan security (for s.16(2A)) or in the flow-back arrangement (for
s.16(2B)) from the total interest expense amount.)
- Incorrectly concluding that under s.16(2)(c), the interest received by the
overseas associate was taxable in Hong Kong either because it was HK-sourced
(credit was taken as provided in HK) or by virtue of it being a deemed trading
receipt under s.15, without first considering the condition of ‘carrying on business
in HK’.
- When applying ‘provision of credit’ test, incorrectly interpreting the place where
the loan was provided ‘from’ or where the lender was located. (Tutorial note: the
correct test was the place where the loan (credit) was ‘first received’ by the
borrower).

Part (b)
- When analysing the tax deductibility of Interest B, incorrectly applying the
restriction of s.16(2B) (interest flow-back test) to the scenario by incorrectly
taking the back-to-back finance (Loan C) as ‘arrangement leading to interest
flow-back’. (Tutorial note: the interest flow-back test does not apply to back-to-
back financing as Loan C in this scenario, unless the financing is effectively a
‘sub-participation arrangement’ where the interposed entity bears no risk from
the financing. However, in this scenario, Loan C only represents a source of

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 funding to finance Loan B, where Inter (HK) is independently liable to the risk
and liability arising from both loans. This is different from ‘sub-participation loan
arrangement’ as referred under s.16(2B).)
- When applying s.16(2)(c), missing some marks by mentioning that the interest
income earned by Inter (HK) was taxable because it was a HK-incorporated
company. (Tutorial note: interest income earned by Inter (HK) was taxable
because Inter (HK) is carrying on business in HK and is sourced in HK; not
because it was a HK-incorporated company.)
- When applying s.16(2)(c), correctly concluding that the interest income earned
by Inter (HK) was taxable because it was carrying on business in Hong Kong but
without explaining the ‘source’ of the interest income

Part (c)
- Wrongly focusing on giving criteria leading to ‘QCTC’ instead of the interest
deductibility under s.16(2)(g) as required.
- Giving oversimplified conclusions that by virtue of the intra-group financing role
of Inter (HK), all interest income was taxable and that interest expense was
deductible, without giving adequate explanations about the legal basis.

Conclusion

Accountants require a comprehensive working appreciation of tax issues. The ATX-

HKG exam requires candidates to identify and explain the principles used in their
calculations and provide a cogent answer. It examines a wide range of issues
commonly encountered in business operations. A skilful application of tax principles
learned is key to doing well in this exam and the examining team will continue to
encourage a comprehensive understanding of tax issues in the business
environment.

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